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The Fed’s Dramatic Inflation-Busting Moves Carry Warning Signals for the Market

Andrew AzizAndrew AzizSeptember 26, 2022
The Fed’s Dramatic Inflation-Busting Moves Carry Warning Signals for the Market

The announcement by the Federal Reserve System on September 21, 2022 that it was raising its benchmark rate by three-quarters of a percentage point for the third consecutive time was followed by an unequivocal statement by Chair Jerome H. Powell: “My main message has not changed since Jackson Hole,” he said in his post-meeting news conference, referring to his policy speech at the Fed’s annual symposium in August in Wyoming, “the FOMC is strongly resolved to bring inflation down to 2%, and we will keep at it until the job is done.”

The increases that began in March from a point of slightly above zero are the most aggressive acts of tightening by the Fed since it started using the overnight funds rate as its principal policy tool in 1990. 

The hikes are based on the hopes that inflation will slide down to 5.4% this year, as measured by the Fed’s preferred personal consumption expenditures price index, which showed inflation at 6.3% in July. The summary of economic projections then sees it falling back to the Fed’s 2% goal by 2025.

Core inflation excluding food and energy is expected to decline to 4.5% this year, little changed from the current 4.6% level, before ultimately falling to 2.1% by 2025.

Referring to increases of .75% instead of the more gradual and palatable .25%, one observer has suggested that  “75 is the new 25,” and that this increment will continue to be imposed until “something breaks, and nothing has broken yet.” 

The Federal Reserve is clearly not retreating from its battle against inflation, even though such aggressive moves to slow the economy will inevitably have negative implications for households and businesses across the nation and in other countries.

Powell has recognized that Americans are experiencing the effects of high inflation, especially in more vulnerable households, but he points out that they would ultimately suffer more and for longer if the Fed were to relent in its commitment to lowering consumer prices.

The present course could mean a recession, job losses, higher credit costs, and other consequences. However, Powell has said that letting inflation continue would be worse and that “delay is only likely to lead to more pain.”

The Fed’s new projections, including meager economic growth and rising unemployment, indicate that officials expect their year-long campaign to raise interest rates to have its intended effect soon. The housing market, which tends to be especially sensitive to higher rates, could be a sign that the Fed’s  decisions are already beginning to have some of the desired effects. Mortgage rates went up in preceding months, and the September 21st announcement was expected to lead to even higher mortgage rates in the coming weeks. The interest rate for a 30-year fixed mortgage, the most popular home loan, had spiked above 6 percent for the first time in 14 years.

The federal funds rate, which is set by the U.S. central bank, is the interest rate at which banks borrow and lend to one another overnight. Although this is not the rate that consumers pay, the Fed’s moves definitely impact the borrowing and saving rates they see every day. This rate hike will correspond with a rise in the prime rate and immediately send financing costs higher for many forms of consumer borrowing. 

One financial analyst has pointed out that credit card rates are the highest since 1996, mortgage rates are the highest since 2008, and auto loans are the highest since 2012.

On the other side of the proverbial coin, higher interest rates also mean savers will earn more money on their deposits. High-yield savings accounts and certificates of deposit are at levels that haven’t been seen since 2009.

There are clear signs of recession. Some officials are predicting that unemployment will rise from its present rate of 3.7% to 4.4% by next year. Increases of that size often are accompanied by recessions.

As well, there are predictions that GDP growth will slow to 0.2% for 2022, rising slightly in the following years to a longer-term rate of just 1.8% following two consecutive quarters of negative growth, a commonly accepted definition of recession.

Powell has acknowledged that a recession is possible, particularly if the Fed continues its aggressive tightening. “No one knows whether this process will lead to a recession or, if so, how significant that recession will be,” he said.

“We have got to get inflation behind us. Powell said. “I wish there were a painless way to do that. There isn't.”

The markets have been especially anxious about a looming recession and the Fed’s promises of higher rates. Stocks tumbled in volatile trading after the September 21st announcement, with major stock market indexes all dropping about 1.7 percent after some swings in both directions.

Traders in financial markets also appear worried that the Fed’s moves, combined with those of other central banks, are steering the global economy toward a recession. Economists are becoming increasingly concerned that many nations’ economies won’t be able to withstand such an extreme slowdown.

All of these developments serve as warning signs, particularly for stock market bargain hunters who might be tempted by market slides to “buy the dip” (purchasing an asset after its value has dropped), a strategy that has gained in popularity over the last decade. In fact, 2022 has turned out to be the worst year for buying the stock-market dip since the 1930s. Instead of rebounding after a decline, stocks have continued to fall, biting into the bankrolls of investors who jumped at the opportunity to buy shares that appeared to be on sale. 
In my opinion, we are certainly oversold in the short term. VIX has not spiked yet and we have not seen a huge volume day that might indicate a bottom. It is a sign we may be getting close to a bottom when everyone is getting extremely bearish.

Andrew AzizAndrew Aziz

Andrew Aziz (Ph.D.) is a Canadian trader, investor, proprietary fund manager, official Forbes business Council member, investor, and #1 best-selling author.

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